Commentary: Amazon Is All Grown Up, Except for Its Accounting
By Timothy J. Mullaney
It has been a fun debate, but it's just about over: The numbers make it increasingly clear that Amazon.com Inc. (AMZN ) is out of the woods. On July 23, Amazon said second-quarter sales surged 21% to $806 million. Operating cash flow was $4.6 million, and its net loss came in at $94 million, 44% less than the same quarter in 2001. Amazon probably won't make money this year under generally accepted accounting principles (GAAP)--a second-quarter currency adjustment of $71 million took care of that--but true profits will almost certainly arrive in 2003.
So why don't more people believe in Amazon? Frankly, it's the company's own fault. Years of arguments over Amazon's accounting have left the online retailer with a dodgy reputation, in a market where credibility is everything. Since 1999, there have been at least three federal inquiries into Amazon's practices, and, though it hasn't had to pay any fines or make restatements, that has hurt Amazon's image. There is a solution. It's time for Amazon to banish two of CEO Jeff Bezos' favorite words: pro forma.
Why is it so important for Amazon to dump pro forma earnings? Now, with Net companies fighting for credibility and investors skittish about all stocks, Amazon needs to play the role of industry statesman. Because of mistrusted pro forma accounting, most people think truly profitable Web companies are rare. In reality, more than 50 of the roughly 200 public Internet companies make GAAP profits now, and others will follow soon. Back in Amazon's early days, before Enron and Worldcom, pro forma may have been a reasonable standard to judge nascent companies whose investments needed time to pay off. But now Amazon, like other dot-coms, must understand that trust is worth more. Amazon took a big step in that direction on July 23 when it became the first Net company to say it would expense new stock options. By embracing GAAP, Bezos can finish the job.
Bezos has argued against projecting Amazon's GAAP results because those are affected by currency and stock market moves he can't control. "For me to predict GAAP earnings would require me to predict our stock price, which I'm not about to try to do," he says. Indeed, the rising euro and an increase in Amazon's stock price hurt the company's financial results in the second quarter. Amazon recalculates the dollar value of its euro-denominated debt each quarter, and those obligations rose by $71 million this time. The cost of stock options was $23 million because employees exercised their options when Amazon's stock rose. But Amazon can--and does--explain those issues on its GAAP cash-flow statement. It doesn't need the pro forma crutch.
Amazon can afford to give pro forma a rest. Besides the currency and stock adjustments, the difference between pro forma and real net income is getting tiny. Amazon's amortization expense is down to $1.3 million a quarter from $50 million a year ago. Even stock compensation expenses of $34 million--mostly in stock options--aren't much considering Amazon's $1.65 billion in sales. And the adjustments will get smaller still as options expire and depreciation falls more.
A clean break would let Amazon focus even more attention on its surprisingly clear path to profits from here. Costs are falling faster than promised, and sales growth--21% so far this year--has picked up from 2001. Mark Rowen of Prudential Securities Inc., who rates Amazon a hold, says it will make $51 million net in 2003, even if sales growth slips to 10%. From there, things should accelerate as Amazon pumps more business through the same warehouses. With real numbers like that, why fool with pro forma?
Jeff, if your foot hurts, stop shooting it. Next quarter, say: "I'll make X for the year under GAAP"--pick a number, or a range to allow for bounces in your stock and the euro. Skip pro forma. A recent Harvard University study shows the stocks of companies that followed best corporate practices beat the pants off cowboys in the 1990s. It'll be more true in this decade, and a white hat means GAAP accounting now.
Mullaney covers technology and finance.